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India's new domestic finance instrument for forests and climate

Blog | Thu, 04 Jan, 2018 · 8 min read
India's new domestic finance instrument for forests and climate

Every year the central government of India distributes tens of billions of dollars in tax revenue to states, based on a formula that includes states’ population, area, poverty, and other factors. In February, 2014, India’s 14th Finance Commission added forest cover to the formula (see figure below), creating a sizable new fiscal incentive for state governments to protect and restore forests. Since forests are a safe, natural carbon capture and storage system, the reform is a big and innovative climate move as well.

The Government of India estimates it will devolve US$6.9-12 billion per year in tax revenue to states from 2015-2020 based on their forest cover in 2013. This amount of money should increase state governments’ attention to forest conservation. Assuming that the 15th Finance Commission retains contemporary forest cover as 7.5% of the formula for distributing post-2020 tax revenue, states that increase forest cover will stand to gain tax revenue of roughly US$174-303 per hectare per year in post-2020 tax revenue, while states that lose forest cover before 2020 will stand to lose the same amount.

My colleague Anit Mukherjee and I sought to determine whether the reform has had an effect yet on increasing forest cover. According to our study, newly published in Conservation Letters, the answer is “not yet.” If the reform were having an impact we’d expect to see forest cover going up faster, or deforestation slowing down more quickly, in states where the forest-based tax revenue transfer is a larger share of the state budget. But at least based on one to two years of post-reform data, this doesn’t yet appear to be the case. There’s still room for more states to protect and restore forests as an investment in future state revenue.

India's new domestic finance instrument for forests and climate
© Maanart at

It’s not necessarily surprising that impacts on forest cover wouldn’t show up in the first year or two of post-reform data. It takes time for state governments to reflect a heightened attention to forest conservation in their budgets, policies, and land-use decisions; time for these decisions in state capitals to have effects on the ground; and time for newly planted trees—whether biodiverse natural forests or plantation monocultures, both of which qualify as forest cover under the terms of the reform—to grow large enough to be detected by the satellite monitors that the India Forests Survey uses to measure forest cover biennially. We hope to look again at impacts after the reform has been in place for at least five years, as well as to test other hypotheses related to the social and environmental impacts of the reform.

India’s reform is an example of ecological fiscal transfers (EFTs), in which higher (e.g. national) levels of government devolve funds to lower (e.g. state or local) levels of government based on their success in achieving environmental indicators. A few other countries, notably Brazil, Portugal, and France, have set up EFTs for protected areas, but India’s are the first for forest cover, and transfer hundreds or even thousands of times more revenue than other EFTs. EFTs represent a creative way to apply internal resources to meet climate goals. They don’t require a budget appropriation or take money away from other priorities, as they are just a new use of revenue that was going to states anyway.

EFTs sit alongside reducing emissions for deforestation and degradation plus enhancing forest regrowth (REDD+) and payments for ecosystem services (PES) as an economic instrument to encourage protection and restoration of forests and other natural capital. An advantage of EFTs relative to REDD+ and PES is that they take advantage of already-established structures for fiscal transfers between levels of government, avoiding the need to design new institutions or assign new property rights. A limitation is that EFTs may be designed primarily to provide local governments with predictable financial resources or to compensate them for forgone resource extraction, leaving only limited freedom to design EFTs to be incentive mechanisms for the increased provision of ecosystem services.

Our research suggests several policy recommendations. Future Finance Commissions should retain forest cover in the horizontal devolution formula as a way of meeting long-term forest cover and climate goals. Conservationists in India have an opportunity to convince state government policy makers that increasing forest protection and restoration can be a profitable public investment in future state revenue. Other countries that devolve revenue across multiple levels of government can potentially adapt similar EFTs to India. And rich countries should match India’s efforts by increasing their own finance for REDD+.